Are robo-advisors winning? Time to play the ethics card

Are human financial advisors engaged in a life-or-death struggle with Internet-based investment services, also known as “robo-advisors”? If you read the industry trade press, you’d be hard-pressed not to draw that conclusion.

“Will Financial Advisors Become Obsolete?” asks one article. “Robo-Advisors Expanding Rapidly,” warns another. “Eliminate the Robo Threat,” commands a third. If you derive a significant portion of your income from investment strategy development and management, should you be worried about this trend? Yes... and no.

Yes, because the robo-advisors have clearly been on a tear of late. According to Clara Shih, CEO and Founder of Hearsay Social, online investment providers have raised some $82 million in venture capital in the last two years. And they’ve amassed more than $2 billion in assets under management. One of the leading services, Wealthfront, achieved its first $1 billion in AUM in about two-and-a-half years, something it took discount broker Charles Schwab roughly six years to accomplish. Wealthfront currently has $1.8 billion in assets under management.

Based on the robo-advisors sales trajectory alone, traditional financial advisors should be concerned. But the numbers aren’t the main issue; it’s the reasons for the growth that should give advisors pause. And there are three of them:

First, robo-advisors have a strong value proposition. They are great proponents of simple, convenient, low-cost, and technology-savvy investing for people who have better things to do.

Second, the marketplace is receptive to their offerings. It’s no accident that robo-advisors are most popular among Millennial investors. In their 20s and 30s, these consumers have grown up with the Internet and have no or little patience for traditional salespeople or sales hype. Just give them a user-friendly interface on a laptop or mobile phone, and they’re ready to invest. If you plan on remaining in the business, losing these customers to online platforms is a stinging blow.

Third, automated investment services may outpace human investment managers due a number of factors, including:

• Tax-aware asset allocations

• Automatic rebalancing

• Optimal allocation

• Tax-loss harvesting

And then there is the cost advantage of investing in passively managed index funds. According to Wealthfront, these advantages add up to an estimated additional return of 4.6%, assuming a $100,000 investment over 20 years in a U.S. mutual fund.

Since robo-advisors in their purest form lack human salespeople, they must rely on their websites to tell their stories. They appear to do a superb job at this. For instance, take a look at Wealthfront’s site. The large home page visual features an animated GIF of a Millennial keying data into her smart phone. Superimposed on the visual is the following text: “Clients trust Wealthfront to manage over $1.9 billion of their assets.” Scrolling further down, the company encourages visitors to “be an investor” using its “sophisticated investment management & advice, without the hassle, high fees, or high account minimums.”

Then comes a performance chart, which spells out, in great detail the incremental advantages discussed earlier. Next comes a discussion of its investment team, which includes Burton G. Malkiel, author of the classic investment guide “A Random Walk Down Wall Street” and Charles Ellis, author of “Error! Hyperlink reference not valid.” The company then touts its low fees, saying it will manage a $100,000 portfolio for less than $20 a month, making sure that key tasks that many investors overlook—such as rebalancing or tax harvesting—get done on a timely basis.

The website sales pitch ends with a review of Wealthfront’s six investment features and photos of 16 Silicon Valley employees—all in the Millennial sweet spot—who have entrusted their money to Wealthfront.

Drilling down further into the site, you discover the company’s helpful investment-education content, along with its clearly written disclosures. Our overall impression? That Wealthfront is professional, client-driven, and careful to do business by the book. In fact, after spending about 15 minutes on the site, one NEA staffer was about ready to open an account and send in a check for $5,000, an account size that requires no investment-management fees (they don’t kick in until an account exceeds $10,000).

But would the staffer have sent in anything more than that? No, and the reason why is the same reason advisors shouldn’t overreact to the robo-advisor threat: the ethics card.

• Agree or disagree about how advisors have the upper hand over their automated counterparts via ethics, or have other thoughts about how advisors can combat the rise of the machines? Please share them on this new thread.